Apple (AAPL): The Genesis of a Contrarian Call

By: Martin Tillier

Posted: 8/29/2012 5:15:00 PM

Referenced Stocks: AAPL;FXCNF;NOK

By Martin Tillier

Most trade ideas fall into one of three categories: range, momentum or contrarian.

Range trades are relatively easy to spot, and risk can be controlled to some degree by using stop loss orders to guard against a break out of the range. Once a break out occurs, there may be an opportunity for a momentum trade, taking advantage of other's stop losses and riding the wave until a new range is established. Contrarian trades are far more sexy. They are also far more risky. Maybe that is part of the thrill. Sometimes contrarian calls are the result of hard, insightful study of fundamentals, but are often just the result of an uneasy feeling.

I have such a feeling right now about Apple (AAPL). It started this weekend when, at a party, four of the five people who knew my connections to the market asked what they should do with their Apple stock. I declined to give any advice, but it set me thinking. If 80% of an admittedly small and non-random sample not only owned AAPL, but were also uneasy about it, should that tell me something?

The positive case for AAPL is fairly obvious and well known. They are a phenomenally successful company that has consistently reported growth above estimates. They have achieved that growth while still building and holding huge reserves of cash. Their products have an iconic status. On top of all that, the company recently announced a dividend and a share repurchase program.

A contrarian trade, however, by its very nature, flies in the face of the obvious. Some seemingly baseless speculation is called for. AAPL has a relatively low forward P/E of around 13. Forward P/E, by definition, incorporates some assumptions about future growth. As a company grows, maintaining the same percentage increase in sales and profits becomes exponentially harder. It is not unreasonable to anticipate at least a slowing of the growth rate. Indeed, it could be argued that the Apple board’s decision to start returning some value to shareholders would indicate that they cannot see any logical growth-related use for their cash.

While Apple’s decision to improve the working conditions at its contractors, such as Foxconn (FXCNF), is to be applauded, the end result may be some downward pressure on margins. Foxconn’s latest earnings release earlier today lends credence to that theory.

The technicals, again, look good on the surface.

The VectorVest chart above shows the AAPL stock price on the top and their proprietary Relative Timing (RT) indicator below. The 1 year chart shows a solid upward trend still intact, and the RT is still above 1 on a scale of 0-2, indicating a positive for the stock. If you are looking for it, though, it is possible to see warning signs. The RT has been flatter than in the past, hovering around 1.15; a far cry from the heady days of the beginning of the year when it registered above 1.5. As I said, it is still in positive territory, but some caution is indicated.

I was in Europe in the late 90’s when Nokia (NOK) was in a similar position. Everything they touched turned to gold. Their search for continued growth led to some unfortunate decisions, not least a move into television (sound familiar?). Apple exec’s have recently backed away from this idea somewhat, so maybe they will not make the same mistakes, but a constant need for growth can lead to some questionable ventures.

I have no desire to join the long list of pundits who have been made to look foolish by trying to pick the top of Apple stock, but the warning signs are there beneath the obvious narrative. In the past, AAPL has been immune to bad news elsewhere, and has richly rewarded investors. If the institutional investors in the stock, who constitute 67% of ownership, feel the same as my very unscientific sample then this may not be the case going forward. I have no evidence to say that this is the case, just a trader’s instinct. When it seems that everybody is bullish, but seemingly everybody already has a position, look out below! Of course, it could be that I just know a disproportionate number of nervous nellies, and should be looking for a new circle of friends.

Disclaimer: The author has no position in any stock mentioned above.

Martin Tillier has been dragged, kicking and screaming, into the 21st century and can now be followed on Twitter @MartinTillier.